Ask the Money Lady,
My wife and I have always wanted to build our dream home, but we don’t know how to get started. I have been to my bank and they said I would have to get a draw mortgage. Is this my only option?
Dear Keith – Building a Dream!
Many people want to build their dream home, especially those that are nearing retirement. Or maybe you want to renovate your current home to make it more suitable to your changing lifestyle. Whatever the case, how do you make this happen when you are seeking a “Construction Loan” from your bank. Construction loans at the banks are not an easy proposition, and for anyone who has done one in the last few years – they will probably be able to attest to how difficult and tedious the whole ordeal can be. But building a dream is always worth it in the end, so let’s look at what the banks will ask you for.
When you are doing a major renovation or building a home, the banks want to do a Construction Draw Mortgage. This is a loan that is initially approved for the entire mortgage amount needed, however only advanced in stages as the work is completed. The payments are made by the borrower for only the outstanding balance as the job goes along and most payments are setup as interest only until the project is finished. A Draw Mortgage can have up to 10 draws but most banks prefer to only offer 3-5 in order to keep administrative and appraisal costs down. You must provide to the bank a detailed construction plan, drawings, permits, and cost schedule. If you are building brand new, the bank will also probably require you to own the land free and clear (without a mortgage) since the first draw will be based on the land value at 65%. You must keep in mind that the banks usually only provide money after the completion of each stage of construction, so that means you may need to have cash assets to draw on in order to start the project. Let’s look at an example.
If you were building a home for $400,000 and the land value was $200,000 – the total value upon completion would be $600,000. The banks would therefore only provide a mortgage for 80% which would be $480,000. You would have to have the balance of $120,000 in cash or at least the full ownership of the land. When you are applying for a construction mortgage, please make sure to have an experienced lender who is familiar with the process and has done them before. There will be a lot of future decisions, stress and even worry when you are going through the construction. Having a bad experience, delays on receiving funds or any surprises from your banker, could leave you with unpaid commitments that only make the whole process feel that much longer.
Keep dreaming Keith, build your dream! Remember to always do your homework before you get started. Interview your banker. Create a well thought out plan and then make it happen!
Good Luck and Best Wishes,
Written by Christine Ibbotson, Author of “How to Retire Debt Free and Wealthy” Follow on Facebook & Instagram